Ringing Up a Turnaround

After a string of acquisitions, this drug store chain is poised to begin reaping the benefits, says George Putnam ofThe Turnaround Letter.

Rite Aid (RAD) is the third-largest drugstore chain in the US, with 4,623 stores located in 31 states. The company was founded in 1962, and has grown through several major acquisitions over the years.

In 2007, Rite Aid purchased the Brooks and Eckerd chains, which made it the largest drugstore chain on the East Coast. Unfortunately, the company took on the debt and integration issues from this major acquisition, and it has struggled to regain its footing ever since.

Under the leadership of CEO John Standley, Rite Aid has done the basic blocking and tackling needed to return to profitability. Standley, who had been an executive at Rite Aid in the early 2000s, returned to the company in 2008 after a stint leading the turnaround of Pathmark supermarkets.

We believe that Rite Aid is now poised to take advantage of its scale and brand to grow profitability and bring value to its long-suffering shareholders.

Rite Aid has a very strong presence in most of its markets. For example, in the Eastern metro areas (excluding Florida), the company has the No. 1 or No. 2 market share position in more than half of those markets. In addition, its 583 locations in California make it a leader in that demographically important state. This presence leads to strong brand recognition that the company can leverage to increase sales and profits.

Management is now focused on increasing store-by-store profitability instead of increasing the number of stores. The company has a number of initiatives underway to increase this profitability.

Its "wellness+" customer loyalty program has been very successful, and the company continues to expand it. Rite Aid is increasing its health-care offerings, including immunizations and in-store clinics. It is also boosting private-label sales and pursuing new measures to improve the customer experience.

None of these measures are blockbusters by themselves, but together they should allow the company to build shareholder value.

The company's progress is shown by the 12 cents per share profit recently reported for its 2013 fiscal year (ended March 2), its first annual profit since 2005. It should be able to continue to add to this in the quarters and years to come.

Rite Aid remains leveraged because of its past acquisitions, but cash flow is decent, and the debt looks quite manageable. While this leverage does increase risk, it also increases the upside potential in the stock if management can continue to grow profitability.

Because of its troubled recent past, Rite Aid looks quite cheap compared to the other major drugstore chains. For example, Rite Aid stock has a price-to-sales multiple of 0.09, compared to 0.66 for Walgreens (WAG) and 0.65 for CVS Caremark (CVS). If management can continue to execute on its initiatives, Rite Aid should narrow that valuation gap.